The last decade has brought unprecedented appreciation in shareholder equity in the United States financial markets. This is evidenced by the explosive growth in the number and size of mutual funds, discount brokerages, equity-based retirement accounts and internet stock trading. The scope of investment participants with diverse investment goals has expanded greatly and includes professional investors and brokers, as well as retirees investing through on-line brokers via their personal computers, employees managing their 401 (k) accounts, and individual day traders.
In order to respond to the resulting increased demand for a wide range of investment products and services for equity investors, financial companies have heretofore reacted within the existing framework of investment vehicles by offering additional products and services. On the one hand, financial companies have offered pooled investment vehicles, like mutual funds, to cover many types of general and specialized investment strategies. On the other hand, financial companies have increased the choice of services available for investors through flexible investment plans, internet stock trading and modified commission structures.
Pooled investment vehicles provide investors with diversification and management, but this comes with certain trade-offs. Investors generally pay significant annual fees that typically increase with the appreciation of their investment. Additionally, it is now well known that for meaningful stretches of time, many managed mutual funds under-perform the unmanaged markets as reflected in one or more market indexes like the S&P 500. While index funds (mutual funds designed to track the performance of an index), like SPDRs, solve some of the problems faced by offering diversified exposure to an index at a cost that is lower than that of typical funds, they do not provide investors with ownership rights in the underlying securities.
Investors in pooled investment vehicles do not have ownership or control in the underlying securities to which they are exposed. As a result, investors give up investment discretion and expose themselves to potential tax liabilities as a result of trading activity in the investment vehicle by its manager or promoter. For example, if a fund manager sells highly appreciated stock in order to return money to other investors who liquidate their shares or because the fund manger has decided to change investments for another reason, the tax liability for that sale will be passed on to the remaining owners of the fund shares. This is especially problematic for new investors in the fund who will realize no gain from the prior appreciation of the stock but will be saddled with the resulting tax liability.
Flexible fee structures and automated, on-line stock purchasing abilities have given investors the opportunity to actively trade stocks, but also expose investors to greater risk. Investors can purchase single-stocks, but must make individual assessments of each stock to be purchased and in most types of brokerage accounts will be required to pay transaction fees for each stock transaction. This creates a disincentive for diversifying exposure to several stocks in each investment sector. Investors are not given the ability or the tools to effectively diversify their investment portfolio.
This diversification is very important to investors, and has driven many investors to the pooled investment vehicles described above. Over the past ten years, there has been a great proliferation of pooled investment vehicles offering exposure to all types of market sectors and investment themes.
There remains a need in the marketplace, however, for an investment that provides and permits flexible investing to promote risk control and diversification, while allowing investors to retain the benefits of beneficial ownership.